Psychological pricing

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This article describes a pricing strategy used by sellers, typically in markets that suffer from imperfect competition, significant transaction costs or imperfect information.
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Definition

Psychological pricing (also called price ending or charm pricing) refers to a pricing strategy that chooses prices whose numerical representation in standard currency units and using standard representations (such as the decimal representation) make the price appear smaller than it really is. Typically, this means choosing a price where the last digit or digits are 9s. For instance. a price of $2.99 may be perceived by customers as "in the range of $2" rather than "almost $3".

Motivation behind psychological pricing

Kaushik Basu has proposed the following mechanism:

  • Customers attempt to save on cognitive effort by processing only the most significant digits of the price and replacing the other digits by expected values of those digits based on the general average in the marketplace.
  • No individual business pricing decision has a significant effect on the average. Therefore, businesses have an incentive to choose the maximum possible values of the later digits (9).
  • This ultimately means that the expected value of the last few digits is the highest possible. This may make it even more difficult for businesses to choose lower prices, since they do not reap any benefits from doing so.